Maryland Gov. Martin O’Malley’s (D) 2012 budget would impose taxes on digitally delivered goods and services and tax purchases made from out-of-state online retailers that rely on referrals from affiliates.

The proposed budget is in bills introduced in the Maryland Senate and House in January. Under the governor’s proposal, digitally delivered goods and services would be subject to the state’s general 6 percent sales tax. The proposal would also tax digitally delivered goods and services such as music downloads on iTunes, ringtones, smart-phone applications, and blogs that charge for their services.

“The sales tax language contained in the governor’s proposed budget is sweeping,” said Seth Cooper, research fellow at the Free State Foundation, a nonprofit, nonpartisan think tank in Rockville, Maryland. “It appears to tax retail sales of digital goods and services by consumers as well as digitally delivered services in business-to-business transactions. But Maryland doesn’t tax most services. So the governor’s proposal would create special tax burdens for digitally delivered services.”

Earlier Effort RepealedThe new proposals reintroduce portions of the Maryland Computer Services Tax which was unpopular and repealed before it could take effect in 2008. The Maryland legislature adopted the computer services tax in a late-2007 special session, without public debate. The outcry prompted legislators to repeal it a few months later.

“Digital technologies can create efficiencies and reduce costs for businesses,” said Cooper. “However, Gov. O’Malley’s proposal for taxing digitally delivered services could actually drive up costs for businesses. And businesses will likely pass those extra costs on to consumers in the form of higher prices.”

O'Malley’s budget proposal ignores the warning contained in the Maryland Comptroller's report that ad affiliate nexus taxes would likely result in a reduction or complete end of tax revenue from in-state affiliates of online retailers such as Amazon, Cooper added.

“The Comptroller noted that online retailers cancelled their ad affiliate agreements with residents in other states that adopted ad affiliate nexus taxes,” he said.

‘Counterproductive, Likely Unconstitutional’ “Maryland businesses and consumers recognized that computer services are an economic force multiplier and that specially taxing them would be a drag on productivity, drive up costs, and put the state of Maryland at further risk of losing business opportunities to neighboring states,” said Cooper.

He noted the idea of a Maryland ad affiliate nexus tax has been floated for a few years.

“Bills for expanding Maryland's sales and use tax to include retail sales made through online ad referrals were introduced in 2009 and 2010, for instance,” he said. “In November 2011, Maryland Comptroller Peter Franchot issued a report analyzing ad affiliate nexus taxes.”

It’s unclear whether states that impose these taxes actually increase revenue collection. With major online retailers typically eliminating ad affiliates in states that adopt such taxes, those states lose the “nexus” that triggers the sales tax, and hence the revenue, while in-state residents lose their commissions for sales resulting from Web site ad referrals.

That, said Cooper, is why ad affiliate nexus taxes are controversial. “More to the point,” he said, “they are counterproductive and likely unconstitutional.”

‘Concoction of Bad Tax Policies’Cooper says Maryland has overspent itself and “has some big bills to show for it.”

He called O’Malley’s budget “a concoction of bad tax policies toward e-commerce.” He said the governor and some Maryland legislators “seem to think the state can tax its way back to fiscal responsibility by raising taxes or imposing new taxes.”

Digital technologies create efficiencies and grow economies and shouldn’t be targeted for excessive taxation, explained Cooper. “It's misguided to saddle digital goods and services that enable the state’s economy with new tax burdens. It will only slow down the state’s economic productivity and further decrease its competitiveness with pro-growth neighboring states like Virginia and Delaware. Fiscal responsibility starts with restraints on state spending.”

‘Next Cash Cow’John Stephenson, director of the Telecommunications and Information Technology Task Force at the American Legislative Exchange Council, said the proposed taxes are a convenient way for Maryland legislators to exploit “the Internet as the next cash cow.”

Stephenson added, “What concerns me is that at a time of economic crisis, a new tax comes along to stifle innovation and investment. When you tax something, you get less of it. Consumers scale back on their purchases, and so do companies.”

Stephenson noted the Tax Foundation’s 2012 State Business Tax Climate study ranked Maryland as having one of the nation’s worst business tax systems.

“The Tax Foundation has ranked Maryland 42nd in the nation,” he said. “Maryland should be doing everything it can to keep these innovations and investments in-state rather than further complicating the tax code.”